Opinion: After the market meltdown, this is the only asset that looks to be a survivor

JohnPrestbo

Chalk one up for the “Sell-in-May” crowd. By going away, they dodged the third quarter’s market trauma that is unsettling the investors who stuck around.

Now both camps are puzzling how to position themselves for whatever lies ahead. One method is to analyze where the markets have been and then project those conditions into the future. It isn’t perfect, and considerable horse sense must be applied in the process, but the exercise can help investors who are yearning for rationality.

To that end, we have assembled data on the market performance of index-based exchange-traded funds in the third quarter (through Sept. 25) and first half of this year. ETFs aren’t as “pure” as indexes — they can trade at premiums to or discounts from their underlying index values — but they are closer to what investors actually experience.

For example, here is how the major asset classes fared. Median performance (the midpoint of those ETFs chosen to represent each category) is a more stable statistic than simple average performance, which can be skewed by one or two outsize results.

Median Market Return

3rd Qtr.

1st Half

U.S. Stocks

-6.85%

1.80%

Foreign Stocks

-11.92%

5.33%

U.S. Bonds

0.26%

0.59%

Foreign Bonds

0.15%

-3.37%

Real Estate

-0.36%

-5.60%

Commodities

-15.76%

-2.32%

Common sense is essential to interpreting this data and using it to posit future positions. For instance, foreign stocks did fine in the first half, and terrible in the third quarter; wouldn’t they revert to average performance and thus rebound? Probably not, because weakening global economic growth is a trend likely to continue.

Speaking of trends, foreign bonds moved from a first-half loss to a third-quarter gain. Wouldn’t that be good to ride? Probably not, because the advance was a temporary benefit as investors dumped stocks and put the proceeds into bonds. Besides, interest rates eventually will start climbing and thereby push bond prices lower.

These aren’t predictions, just ruminations to show how the process works. In this spirit, the only asset that possibly looks promising is real estate, meaning REITs (real-estate investment trusts) trading in the stock market. REITs’ return was the worst of this lot in the first half, but much better in the third quarter and especially in the past two weeks. Improvement in the midst of chaos shows auspicious resilience.

Sometimes more detail is needed to hunt for potential clues. But the following table about the U.S. stock market shows that clues aren’t easily extractable from the noise.

Median Market Return

3rd Qtr.

1st Half

Large Cap

-6.41%

1.30%

Mid Cap

-7.35%

4.07%

Small Cap

-9.68%

4.54%

Growth

-6.02%

4.90%

Value

-8.65%

0.58%

Low Volatility

-1.86%

-0.18%

Momentum

-4.92%

5.36%

In almost every instance the stock market fell by more in the third quarter than it rose in the first half. That suggests the market was highly vulnerable to the news about slower growth emanating from China and much of the rest of the world. Unless that news reverses direction, vulnerability is likely to persist for a while.

The one exception is the momentum strategy, which focuses on stocks already moving higher. The strategy magnified the first-half return and cushioned the third-quarter decline. By contrast, the low-volatility strategy exacted an upside penalty in the first half in return for its superior downside protection in the third quarter.

For stocks outside of the U.S., currency-hedged vehicles had the same effect on results as the momentum strategy did domestically.

Median Market Return

3rd Qtr.

1st Half

Foreign Stocks

-11.92%

5.33%

Emerging Markets

-19.18%

3.06%

Currency Hedged

-8.63%

8.50%

Currency fluctuation was rampant in the third quarter as China devalued its yuan and the U.S. dollar
DXY, +0.62%
continued strengthening. The benefits of hedging could be less in quieter periods, or when the dollar is weakening.

Diving deeper into U.S. stocks brings us to the sector level. Here we find some more common-sense issues but also some positioning possibilities. In the table below the indented lines indicate a subsector that also is part of the full sector listed immediately above. Every sector has subsectors but only two are shown here.

Median Market Return

3rd Qtr.

1st Half

Communications

-6.35%

2.10%

Consumer Discretionary

-4.12%

6.30%

Consumer Staples

-2.06%

-0.30%

Energy

-17.96%

-4.10%

Financials

-6.44%

0.50%

Health Care

-11.13%

11.40%

Industrials

-7.86%

-2.40%

Home builders

-1.39%

6.85%

Natural Resources

-17.94%

-1.60%

Precious Metals

-19.05%

-1.25%

Technology

-4.76%

1.70%

Utilities

2.64%

-10.65%

Common sense suggests that utilities aren’t likely to extend the trend of negative first half to positive third quarter. U.S. economic growth, while the strongest in the world, is still sluggish relative to previous expansions, particularly in manufacturing. Also, the eventual prospect of rising interest rates will lessen the allure of big utility dividends.

Falling commodity prices have hit energy and natural resources hard. At some point energy will start to rebound, but not until supplies are trimmed back closer to demand. Natural resources likely will remain weak until there are signs that declining global economic growth has bottomed out; China will be watched closely. (By the way, the precious metals subsector consists here of gold miners, not the prices of the metals themselves.)

On the promising side of the ledger, the fact that home builders resisted most of the third-quarter selloff suggests that subsector could show continuing strength. Consumer discretionary didn’t retreat all that much from first-half potency, so maybe there is more life in that trend. Health care was knocked back from its highflying first half, but the steadily aging U.S. population still works in its favor.

Predicting is difficult, especially about the future. (Thanks, Yogi Berra!) Yet investors often must do exactly that as they try to squeeze the most from their portfolios. Sometimes the market itself drops hints, but finding and interpreting them requires common sense and more than a little humility.

John Prestbo is retired as editor and executive director of Dow Jones Indexes, now part of S&P Dow Jones Indices, in which Dow Jones & Co., publisher of MarketWatch, holds a small interest. Prestbo also is an adviser to MarketGrader Capital, which scores stocks on the basis of fundamental factors and chooses components of the Barron’s 400 Index.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.